Last updated on June 9, 2022
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Allen Bond, managing director and portfolio manager at Jensen Investment Management in Lake Oswego, Ore., joins the podcast to provide some stock picks for an increasingly uncertain — and inflationary — time in global financial markets.
Content Highlights
- Investors have two major issues they’re grappling with right now: Ukraine and inflation (5:51);
To protect against inflationary pressures, Jensen looks for businesses that have pricing power (11:11);
- Mastercard (MA) and TJX (TJX) are two such stocks (13:29);
Background on the guest (19:36);
- Three additional stock ideas, starting with ADP (ADP), another company that is difficult to displace (28:54);
Broadridge Financial Solutions (BR), the leading provider of proxy services (35:51);
Pfizer (PFE) has sold off since making Covid vaccine headlines last year, but continues to generate a ton of cash — and put it to productive use (43:26).
More Information on the Guest
- Website: JensenInvestment.com;
- Not intended as investment advice.
Video Highlights from Our YouTube Channel
Transcript
Nathaniel E. Baker
Allen Bond of Jensen Investment Management. Thank you so much for joining the contrarian investor podcast today. Been looking forward to this recording, because this is a kind of an knowable time here. In global financial markets, we have a bunch of uncertainty going on, starting with the Russian you invasion of Ukraine. And we also have interest rate uncertainty, and volatility, inflation. There is a bunch of stuff here that has kind of been vexing investors and vexing markets. They seem to be okay with it as we record this day after a big rally on Wall Street. But just curious to start off, if you can give us obviously, there’s no such thing as complete certainty, but just an idea of where you see markets now. And risk.
Allen Bond
Yeah, well, thanks for having me on the podcast.
Nathaniel E. Baker
Thanks for coming on.
Allen Bond
Honestly, this is something I’ve been looking forward to as well. So you know, to answer your question, I won’t go back too far. But I think it helps to go back really a couple years to kind of frame up what’s happened in the market? And why? Because I think it kind of speaks to where we’re at today. And I think it kind of helped frame up some of the questions you talked about in terms of interest rates. And and then the the crisis in Ukraine is, we’ll talk more about this, but you know, it Jensen, we’re long term investors, and it’s kind of a nebulous term. But the way we kind of think about the long term investors as we want to think about investing through the cycle, so we kind of think about the cycle as one peak in the market to the next peak in the market. And so, for this conversation, we think it’s really interesting to think about the bottom of the cycle. So that would have been about two years ago, almost exactly two years ago is March of 2020, the market bottomed out in a very severe and sharp bear market associated with the onset of the COVID 19 pandemic. And as the uncertainty around that began to resolve the market, we’ve seen a sharp rally off of that bottom. And really, we think that rally was fueled in many ways by extraordinarily easy monetary policy and extraordinary amount of fiscal stimulus. And the result, if we if we include 2019, in this period, it’s really remarkable the markets up cumulatively, and I’m looking at the s&p 500 index, almost 70% in those three years 2019 2020 2021. And it’s amazing to think that that occurred in the face of a global pandemic, unlike, you know, it’s kind of a generational thing. None of us have seen something like this before. But we really do you think it was the market looking forward looking through the pandemic disruption, we saw very quick and largely successful, in many ways, healthcare response to it, terms of vaccines, and so forth. And then again, we’ve seen some really, really generous policies. What we’ve seen more recently, is that the combination of this stimulus, and then some hiccups in the global supply chain as we start getting back going, has resulted in inflation. And so that kind of brings us to where we think we’re kind of an inflection point right now, in terms of these large market drivers. The reason is that monetary policy, believe it or not, is still very easy. You know, fed fed, fed rates are near zero, the Fed is still doing quantitative easing purchases, but they’ve had they’ve indicated they’re going to start raising rates sooner rather than later. So we expect that to go more, more hawkish. And then fiscal policy is kind of becoming neutral. So those drivers are gone. And now we have to grapple with higher inflation. And like you mentioned, a rise in interest rates. And then the disruption in geopolitically with Russia and Ukraine kind of adds fuel to that fire from a kind of an economic or financial implication standpoint. The result is the markets down this year, I think, what 7% or so, as we record this, we’re giving back some of those gains. I’m sort of frame up where we’re at today. I think there’s there’s two issues that we’re grappling with, but they are they’re related. One is the resolution of this issue in in Ukraine. And you know, goes without saying but we’re gonna say it anyway, the you know, our heart goes out to the people in in Ukraine. This is a this is a tragedy and it’s a crisis. And it’s first and foremost that at a human level, from an economic standpoint, or from a financial standpoint, in and of itself or in about themselves, Ukraine and Russia, they’re about 2% of global GDP combined. So we don’t expect a huge amount of disruption from that standpoint, where we see the potential for disruption is more second and third order, those obvious second order impact is on cost. And on this inflationary issue that we’re already dealing with, in the sense that Russia is one of the key energy providers to Europe, and globally, and Ukraine is a key commodities provider. And so if if we see disruption in Russia’s energy in trains commodities, that can add to that inflation. And I think an add to, you know, maybe a slowdown in Europe, the larger the maybe the next order impact would be does this geopolitical instability there? Right now it feels like it’s isolated, does it become a contagion does, do we see more activity and then then, and then that would be more of a broader disruption from a GDP standpoint? So that’s how we’re thinking about the market kind of the last couple of years. And then how Ukraine and Russia and the disinflationary question or the persistence of this inflation sort of fit in?
Nathaniel E. Baker
Interesting, yeah, that’s a really good way of framing. I couldn’t have said it any better myself. So what did where do you think though, cyclically, we are here? Like, if whether it’s quadrants, or what stage of the economic cycle? Are we at? Is there still juice in the business cycle? At least in the US? How much and for how long? Yeah, it’s?
Allen Bond
You know, that’s a great question. This is obviously kind of a weird business cycle, in the sense that, you know, like I mentioned, we were, we were still on an economic expansion, two years ago, and then the pandemic hit. And it just said, Everything spiraling. And so what we’ve seen, really, the economy is just in this weird spot where we’re dealing with disruption, still dealing with disruption, from the pandemic, but also reacting to, you know, a tremendous amount of stimulus. And so it’s creating kind of a weird business cycle maybe a bit faster, because if you think about things, just let’s let’s just look at it, relative to the last cycle. So the market bottomed out in early 2009, the Fed went really, really easy. We saw some fiscal stimulus we saw, you know, at that time, kind of unprecedented Fed policy with zero interest rates and quantitative easing. And that, that stayed in place for about five years. So the Fed, essentially what neutral on QE, in late 2014. And then, and then started raising rates in 2015. Right, so that was about, let’s just, say five years of very, very easy Fed policy. Right now, we’re about two years into that. And we’re already talking about interest rate increases. And so the reason I bring that up is you think about when the Fed starts to tighten shorts, and talk about tighten, that can be kind of thought of as mid cycle. And I think that’s probably the right way to think about where we’re at right now. But it’s happened very, very quickly as a result of some of these other factors that we’re at. And so yeah, so what we need what, you know, we’re gonna see as the the Fed and other global financial leaders their ability to navigate and try to create some sort of a soft landing. And that it’s, it’s appears to be a lot trickier given that the the level, the magnitude and the what seems to be persistence in terms of inflation.
Nathaniel E. Baker
I was gonna say, has the Fed or any central bank ever been able to engineer a soft landing? It seems they always talk about it, you know, the last couple cycles that I’ve been around for at least, and it never seems to happen? I?
Allen Bond
Yeah, I think there may have been soft landings in the past, but probably before my career started, you could argue that they were on their way to engineering a soft landing the last time around, before the pandemic hit, because the economy is still growing, they’ve raised they raised rates, created kind of a stability in terms of rates. And, and then, you know, the unexpected shock, and we had a pandemic that sent us into a recession. So, so who knows that that could have been it? But it’s it’s a great question. And I mean, I believe that that that task is more difficult right now, given. Again, given that we’ve got a lot of inflation, but we also still have a lot of uncertainty with the pandemic. Now, this geopolitical issue. Well,
Nathaniel E. Baker
how concerned are you about inflation? You just mentioned that, you know, and now especially with, you know, with Russia becoming a pariah state, there’s a big supply of oil, gas and other commodities that are just not going to be available, presumably. And it’s not entirely sure where the people can go to, to replace it. And so that would really leave prices going only one way which is upward, can the and which producers will then pass on to consumers can consumers stomach this? We’re talking about $5 gas, probably more in the US and for how long do you think?
Allen Bond
Yeah, you know, I can tell you, I’ll start with kind of how we think about it as investors and then and then maybe talk more about broad, broad economic terms, you know, as investors, we manage The investment strategies. And so we’re looking for businesses that we think are quality businesses first and foremost. And so these would be businesses with competitive advantages, and free cash flow generation and strong balance sheets, and so on and so forth. And one of the ways this manifests itself in a period of inflation is pricing power. And so as investors, we’re looking for businesses that have demonstrated pricing power, or have business models that lend itself to pricing power, because we think that’s how the businesses can manage with cost inflation. They’re all they’re all seeing it. And then so that we believe the winners from a business standpoint will be ones that have business models that allow them to pass costs on. The other side of the equation is is is difficult. I don’t you know, we’re not we’re not economists were You were investment managers. I would just say that it. The one thing we are watching, though, is wage inflation. So we’re seeing cost inflation, which say commodity costs or energy costs, what have you, that is leading to wage inflation in the one thing to keep in mind is that the employment certainly in the US has come roaring back. And so we’re already we’re kind of at a tight point from an employment standpoint, which as costs come through, that’s putting pressure on wages. And that’s really that cycle that we’re trying to try to monitor and understand is how long does that that that inflation cycle persist? You know, and at what point will it slow down a little bit?
Nathaniel E. Baker
So a lot of what you mentioned, seems to imply staples, consumer staples, maybe utility type of things that have the pricing power, where consumers aren’t left with any other choice, but to get those products anyway, is that is that a fair statement?
Allen Bond
Yeah, so we’re certainly seeing some of the consumers, consumer staples companies. So the two we are our flagship strategy are Pepsi and Procter & Gamble, and both of those companies have been successful the raising prices in that’s that, certainly in line with our expectations, those are both companies that have have done market share positions in the in the spaces that they compete, and strong brand names and so forth, that resonate with consumers. And that gives them the ability to raise prices. I think, you know, we’ll talk a little later about one stock idea, but but another stock that we own, I get a lot of it comes down to business model. And this is something that maybe is a new one, right? So one of the stocks we own is MasterCard, MasterCard, in many ways, their revenue model is a function of global spending, right? So they earn a tiny fraction of each time their card is used in a transaction. That’s their revenue model. And so if we have inflation, inflation means you’re just broadly speaking more money is being spent nominally, that means they take a bigger nominal piece out of that, and it’s a natural inflation hedge that sits inside their business model. So this is the I think, I think this is the kind of the, one of the things that’s really critical was talk about know what you own, right? No. And we, for us, that’s really, really important. We own 29 stocks, we’re not in this as again, in our flagship flagship strategy. We, you know, this is very much a high conviction strategy. So to us, it’s really important understand the nuances of these businesses that were able to adjust and adapt as circumstances change. And MasterCard is a good example of that. Another one, very different business, but also a very nuanced ability. From a pricing standpoint, we own TJX companies. TJX is an off price retailer, and strategics. They own TJ Maxx, they own Marshalls, they own home goods, and their business models, essentially, based on taking advantage of kind of the perpetual inefficiencies in retail, supply chains, apparel, and other types of retail supply chains. Where there, there’s overproduction. There’s missed orders, there’s things that happen. And this is just because there’s such a lag and about 18 months lag for traditional retailer between order and delivery, things happen. And this, this is just it’s just the nature of the business. And so what TJs tries to do is they buy late in the cycle, and they buy, they buy at a price where they can sell at a price where they’re gonna have a big discount relative to traditional retailers. And what’s important for them is just to maintain that gap. So whether or not they if they pay $10 for something, and they can sell it for 20. All that’s great. But if they have to pay $15 for something that they can just sell for 25 Assuming that the the traditional retailers are doing the same thing, which the economics suggesting normally well, so again, another company with I would say kind of a very nuanced ability to pass price, where they’re still actually there’s very good art into providing value.
Nathaniel E. Baker
All say they are I mean, I don’t like to shop in fact, I hate it but a couple of times a year I will go into a Marshalls or TJ Maxx and I was just there maybe a month or so ago Marshalls and so that’s why this is fresh and they have this discount shelf at the center of the store. And you go there and there’s stuff that is available literally for pennies on the dollar, like Staples and other things. It’s It’s really amazing. So as a value shopper it’s a it’s a pretty good deal. especially with prices going up everywhere else.
Allen Bond
Yeah, the thing with TJ Maxx that’s interesting is they’re very much still a brick and mortar retailer, they get about 1% of their sales from an E commerce standpoint. And the reason is the reason I bring this up, it’s related to your point is they’re trying to create this treasure hunt experience. So what they’re trying to do is they are trying to get, they’re trying to flow merchandise in and out of their stores very quickly. So if you look at their inventory turns are much higher than than an average retailer is. And they’re trying to they’re trying to use their buying and merchandising to get merchandise in there that they can buy, they can sell quickly. And if and that the other thing, they’re very aggressive, if things are not selling, they will quickly mark them down. Because the way that business model works is to maintain freshness. And what’s what’s interesting about that is we’ve seen this big change in retail, where e commerce is really disrupted a lot of retailers and T GX is the one that we haven’t really seen that yet. In fact, if you look at their numbers, and they’ve been distorted, because they’ve been mandated to close stores, certainly in the US kind of back in 2020. But even last year in Europe and Australia, they’re global. It’s hard to it’s hard to get that like for like the same store sales, but they recorded it in way you can’t see it. And they’re they’re pretty good, pretty good evidence that that model is still resonating with consumers.
Nathaniel E. Baker
Yeah, yeah. And you know, as a completely novice consumer myself, I mean, I’m good to exhibit as good an exhibit as anybody I guess. Very cool. Alan bond. I want to take a short break and give our sponsors a second to be heard. But don’t go anywhere. Because when we come back, we are going to provide you’re going to have some stock picks that you are bullish on right now with the understanding of course this is not investment advice. And there’s some other things I want to ask you in this very fascinating conversation. If you are a premium subscriber Do not touch the dial, you will not get the break to become a premium subscriber. Visit the website contrarian pod, thought substack.com. And sign up. Alright, welcome back. Everybody here with Alan bond pm and MD at Jensen Investment Management in Portland, Oregon. Alan, this is these the segment of the show where we ask our guests a little bit more about themselves personally and professionally. And their background, how they started in investing, and how they got to their current station in life. So curious to hear from you. Your story so far, not the entire life story that would be here for a little while, but just you know, the more relevant parts.
Allen Bond
Yeah. Okay. So I’ve been with Jensen now for just hit my 15 year, anniversary last month. So congratulations. This has definitely been the longest part of my career. And I’ve been an analyst and portfolio manager here the whole time. Well started out as an analyst, but I’m still an analyst and portfolio manager as well, on on two of our strategies. Prior to Jensen, I was actually working on the fixed income side of things. So I was a corporate and high yield bond analyst prior to that, which it sounds like kind of a leap, although the work I was doing is that is certainly desirable. An analyst is just about as deep as you go. Is an equity analyst trying to understand businesses, the questions you’re trying to answer a little different, you know, in equities, we’re trying to answer. Does this company have a sustainable competitive advantage? Does this company have opportunities to grow and create value? Those are the two primary questions we’re trying to answer, high yield, it’s like you’re Is this a good business? Are they going to be able to pay their interest and pay me back at the end those are, but you’re the type of analysis that goes into best is pretty similar. I started the business in 1998. And it kind of what sparked my interest, I suppose, you know, I was an undergrad, I took some finance classes, and it just sort of clicked and I was like, I think I kind of like this. And so I was lucky enough to build a find a way to make a career out of it. I finished a CFA in 2002. So I’ve kind of done that track as well. And I just from personal level, I think it’s a phenomenal career. It’s it’s something where the market kind of keeps you honest, you get the chance to learn something new just about every day and work with a lot of smart, dedicated people. So I think it’s a it’s a really neat place to be
Nathaniel E. Baker
very cool. Nice. And so yeah, let’s let’s talk a little bit about these stocks. And you mentioned MasterCard at the outset. And how is that different from visa? I’ve always I’ve always wondered this RNA fundamentally the same?
Allen Bond
Yeah, that’s that’s a good question. And the reality is not much. You’re very similar businesses, they both were spun out of essentially bank consortiums. So they were that’s how they started. That’s that was how they originated. Let’s just, I’ll just try to give you so the basic big difference. The main difference is visa larger. If you look at market share, based in terms of number of transactions, or whatever, visa is 60% ish, MasterCard more 30 ish. So it’s, that’s the biggest difference, their revenue model is identical. And it there’s some there is a caveat here that may be worth kind of, sort of interesting, I think. So you think about Visa and MasterCard, they operate what are called open loop networks. What that means is they facilitate the secure and ficient interchange between banks when we make a transaction. So when we think about like, let’s say you go to the grocery store and use your credit card, the credit, the grocery tries to be able to take your credit card. So they have a bank that they work with that allows them to accept your credit card. That’s often called an acquiring bank. Your credit card has been issued by a bank. For me, it’s Bank of America. So bank, America is my issuing bank. So now I’ve got me the grocery store, their bank, and my bank, MasterCard and Visa both just sit in between the banks, and they facilitate again, that the communication language and channel that allows for secure and efficient transfer of assets between those banks. And that’s all they do. And so again, they take anything you people private about interchange interchange is essentially the, if I spend $100, at the grocery store, the merchant only takes about maybe, I don’t know 99, something of that. And then that that fraction, that difference is split among those different parties, MasterCard, and visa get a sliver of it, most of that money goes to the issuing bank, so whoever your credit cards with gets the vast majority of that. And so again, when I talk about MasterCard, their revenue model is very much a function of just global spending. And the big the big growth story with them. And visa has been that electronic transactions are increasingly displacing cash transactions around the world. So there’s this massive secular growth driver that’s benefiting both of those businesses, because of their, their kind of a transposition, you know, brand name, distribution, network, acceptance network, so on and so forth. We think these are tremendous competitive advantages shared by both businesses. Where this is different. If you think about an American Express is a good example, they are called a closed loop network. So American Express does all of that stuff that I described, they are the issuer of the card, they are the acquiring bank that represents the merchant, they are in and they get there, the card issuer and and there’s you so they’re really they’re really there and and they take the interchange in the middle. And so it’s a different business model where for them and opens them up more to like credit risk, you know, with consumers and their their credit words MasterCard, and visa, really don’t take credit risk. In that regard. It’s such a different business model, they get a capture more of that spread. But they also it’s not scalable. And it’s also not as it also is not a pure play as much as fast Visa MasterCard are.
Nathaniel E. Baker
Yeah, really interesting. I mean, it’s amazing business model, this, this idea that whoever had to create this little tiny middleman, that just I mean, it’s literally just a sticker on a card, right, they don’t lend any money to your point,
Allen Bond
they do it, I will tell you this about MasterCard, um, we, one of the big things that we try to do as investors is we try to, you know, we, we pride ourselves on due diligence. And we will often get, as part of every diligence, we try to meet with senior management. And with MasterCard, we were able to do that. And we have that meeting. And the one thing I was the lead analyst on it. So this could be a business or would be very easy to become complacent, because like you said, they are they are doing one small sliver of a thing. It’s very lucrative, and there’s a natural growth driver. And but you have to think about it that is a technology business, meaning that there are competitive threats. And if you’re not willing to stay a step or two ahead of competition, you can get displaced pretty quickly. Now MasterCard, and visa have a huge leg up on competition, because they generate so much cash for investment they can they can go out and buy new technologies, they can develop technologies, they put a lot of effort into security, and a lot of effort into analytics so that they collect a lot of data with these transactions. And then they can package create analytics and sell that data. That’s been a really, really great kind of diversifier and growth driver for MasterCard. But what struck us when we talked with MasterCard, and their leadership was that this was a company that was very much focused on the next thing, it wasn’t about, hey, we’re gonna sit back and kind of flip the coupon on this phenomenal business, we’re going to take we are going to do that we’re going to reinvest. And so what they’ve done from a reinvestment standpoint is they’ve tried to open up what they call new payment rails. So think of credit card payments as one rail, there’s a debit card with a different rail business, the business would be a different rail. And in in there, they’re investing in that, again, they’ve invested in in kind of data and analytics and security. And this is really what’s I makes us feel comfortable that MasterCard, not only a great business for today, but they’re taking steps to make it a good business for the future as
Nathaniel E. Baker
well. Yeah. To that, are there any concerns about I mean, you mentioned displacement. I mean, there’s been a couple that immediately come to mind, you know, buy now pay later. And then the decentralized finance, I mean, to the extent that you take that seriously, you know, if you do, and I know that they there have been some acquisitions of BNPL in that space. But how much of a concern is that as far as being a discipline? Yeah.
Allen Bond
So buy now pay later is something that MasterCard is, is doing themselves? Yeah, we’re piloting it right now. So this is what it really just falls back to where is their competitive advantage. Their competitive advantage is their ability to see what and securely trend, you facilitate transactions between banks. And a lot of the FinTech that we’ve seen, maybe they’d like to do that. But they, they pretty quickly realized that it’s much more efficient for them just to partner with MasterCard, and or partner with Visa, and then allow them to try to make maybe the front end easier or better either for the merchant, either for the consumer. And so in the MasterCard has been very open about partnering. And they’ve done everything they can to make it make them a beneficial and easy partner. So they maintain their moat around there. They’re part of the financial networks, or they’re, they’re part of the transactions. But they’re allowing innovation to happen around that as long as they their core business stays intact. And then again, they’ve also acquired a lot of these types of businesses they are they are piloting their own Buy now pay later program. So this is a you know, I again, I think a business that’s it’s trying to maintain a very strong legacy business, but also before looking.
Nathaniel E. Baker
Cool. Alright, so now you have three, these three ideas that you want to talk about here. Let’s take them in alphabetical order. The first one is, it’s just three letters, starting with an A. Yeah, tell us about that. Okay,
Allen Bond
yeah. So yeah, with ADP, I think formerly known as automatic data processing. So ADP is the leading payroll processor in North America for large businesses. So they process payroll, they have human resources services, they have a large growing outsourcing business. And it is a business that is characterized by very high customer switching costs and very high scale advantages. And then therefore a very high customer retention rate. So this is what we think the crux of the competitive advantage for ADP is, is that they can process payroll more efficiently. And, and more easily than any one individual company can do it. And so once they’ve won business, it’s very unlikely that business leaves from them or with a competitor. And so their customer retention rate is over 90%, consistently. It’s also, you know, a revenue model that we think is really a powerful revenue model, I kind of talked about the nuance and understanding this. And this is one of the things that we really focus on more trying to analyze businesses, how do they make money ADPs revenue model is largely a kind of a fee per transaction. So every time they cut a check, every time they make they do something, they recruit, they create revenue, that creates revenue recurrence, in the sense that it’s, you know, as long as they’re writing these checks and doing these things, they’re going to generate revenue, it also makes it relatively easy to model or easy. It’s predictable in the sense that you can kind of okay, well, we understand what’s going on with employment growth, we know that what their percentage of market shares and so forth, gives us pretty good proxy for understanding how EPS business should perform. It also creates a lot of natural operating leverage. So this means that sales will tend to rise faster than expenses over time, which which means improve profitability. That is the core and then and then from a growth standpoint, they’ve done there’s two things going on. Number one is we’ve already talked about the employment markets come roaring back. And that’s a that’s a benefit for ADP. The other thing they’ve done is they’ve they’ve tweaked their their modeling made more of a kind of software as a service or cloud enabled model that’s allowed them to go down market and work with smaller and medium sized businesses, which is there’s a lot more opportunity in terms of numbers of businesses there. So that’s kind of our our investment thesis on ADP kind of long term. One thing that’s interesting about ADP right now is there’s kind of this part of the business that I think sometimes gets overlooked. That’s kind of a natural inflation hedge. So it’s part of their business, they receive cash from their clients, before they have to pay the cash out, right, when they’re, they’re cutting paychecks. And last quarter, they had about 32 billion in these funds that are held for clients. And they are able to invest this, these these assets in very short term safe investments. Last year, they earned $422 million in interest income from those cash balances. And what’s great about this is it’s almost pure profit, there’s not a lot of overhead associated with this, it’s just kind of a byproduct of business drops right to the bottom line. So it’s good for profitability. Also very good from an inflation hedge standpoint, you know, they’re investing most of these instruments this this money in very short term safe, fixed income instruments. So as interest rates go up alongside inflation, which typically happens, they can earn better interest rates on this these funds. The second thing is these funds are largely a function of wages being paid. So if we have wage inflation, again, the nominal amount of these funds held goes up, which means more opportunity to earn interest and drop right to the bottom line. So we think there’s there’s a really good long term store and kind of a neat short term story with ADP right now. And I think what I would say is this is a stock, that’s underperformed a little bit start the year. Um, we think there’s a couple things going on number one is we’ve seen a broad pullback in tech stocks and ADP is in the tech, it’s even it’s not a traditional technology company, but it’s in that sector. So they’ve kind of got caught the downdraft there. And then their guidance for the year was a little bit lackluster, given what we’ve seen in employment growth, although we suspect there’s probably some conservatism built in there. So short term, some concerns about tech stocks, maybe some, you know, questions about what we’re where guidance comes in for the year, long term, we think a very, very powerful business model, with good growth drivers, and this kind of short term inflation hedge built into it.
Nathaniel E. Baker
But isn’t a lot of the business cyclical. And if there’s a recession, there will be at some point, then employment will decline. And wouldn’t that hurt them?
Allen Bond
Yeah, there’s, there’s no doubt about it. And I think that’s, that’s something that you, you want to think about, I’m sort of, we’re trying to think the right way. And we’re kind of trying to, you recognize that as is an issue and a risk. What what where we would come down on that is understand the business model, and what the drivers of the business model are the potential for cyclicality that’s something that as we develop our financial models and our forward looking projections, those assumptions get built in there. And then we know the one thing we’ve talked about a little bit from our investment strategy, we’re focused on high quality businesses, and we’re very much focused on them for the long term, you know, on average, we’ll sock seven to eight years. So we want to own high quality businesses that we think are going to create business value, and that we can kind of participate alongside of that as shareholders. The other component that’s really critical for us is we want to make sure we pay a fair price. And that’s where I think we’re what we how we try to answer the question that you just asked about cyclicality is, well, let’s make sure we understand that and that is reflected in our financial projections. Let’s make sure we pay a fair price. ADP, again, we own Sox seven, eight years on average. And we’ve owned ADP on and off over the 15 years that I’ve been at Jensen, but we actually have been a little bit more active with it, where we’ve worked, there’s been moments where we think the stocks gotten ahead of itself pretty meaningfully. And we’ve either paired it back or sold out of it, and then tried to try to be, you know, opportunistic, about when we got back in, we put it back to the portfolio in March of 2020, for the most recently, and that was during that kind of that concern about, you know, the, the onset of the pandemic and how that might impact employment. And so we thought, okay, this is a high quality business, we think over time employment will come back and we were able to get in, I think, at a good price.
Nathaniel E. Baker
Is their balance sheet flexibility? Or do they have a lot of debt that needs to be serviced
Allen Bond
or suspected a very strong balance sheet? I don’t remember exactly what it is off the top my head that effect, but this is one of the one of the stronger ones that we follow here. So that’ll come in there as well.
Nathaniel E. Baker
Yeah, they’ll come in handy when there’s a recession for sure. Very cool. All right now, next Broadridge. Financial, let’s talk about Yeah, okay, so
Allen Bond
Broadridge may not be as well known, although there’s a lot of similarities between Broadridge and ADP, and sort of the way the business model works. And it’s also a very strong business. So Broadridge is the leading provider of proxy services in North America. So I think we all kind of know what proxies are. But I think the best is investors, I should say, we know what they are, but but the way I think they’re best thought of is kind of regulated communications that have to occur between companies and investors. And Broadridge is key services, basically providing the link between issuers, so that would be companies mutual funds, ETFs, and investors and their ability to identify those investors and then distribute the proxies to investors. And the reason that’s critical is it’s kind of a labyrinth, the it between the issuer and the ultimate investor where the investor may have their their investments held up like a broker, like Charles Schwab. And so then and then and then so the the records of their appointment of that holding are actually just oh, it’s it’s owned at Schwab. And then you have to go back and look okay, well, it’s actually this investor that some Schwab but there’s there’s, there’s a lot of different kind of moving parts between those things. Broadridge is basically developed the infrastructure to to very efficiently create that link. And that’s really their key service offering. Very much like ADP. It’s something where once a company outsources proxy services to Broadridge. It’s very unlikely they’re going to take it back. Broadridge does it much more efficiently, then it easily than the average company is going to do it? They have about 80% market share in the North American proxy business, a very strong business there, their client retention is well above 95%. So again, this is a sticky they’re they’re the entrenched player in a business that’s very sticky. We think this is a really powerful competitive advantage. Network effects scale, so on and so forth. And that’s the way we think about competitive advantage. The other thing and this is similar to ADP is again understand revenue model understand how The business makes money. And in this case, it’s a very stable revenue model, they essentially earn revenue on a per communication basis. So that would be a paper based communication that could be an electronic communication, whatever they communicate, they earn a fee. And that means that their revenue is gonna be much more a function of the overall ownership of stocks, mutual funds, ETFs and other financial instruments than it is about the level of capital markets. So we looked at this historically, we’ve seen it more recently, as capital markets fluctuate broad ridges, revenue doesn’t fluctuate alongside with that in a long ways, their revenue is much more a function of overall ownership. And what we’ve seen in the last couple years is this kind of quote, unquote democratization of investing, which has led to more holdings of investment instruments, and therefore more proxy deliveries. And this has been a really good growth driver for broad rich. And so we think about Rogers more as a is a very good business. Solid consistent revenue model, strong competitive advantages. And then they’ve invested that, again, into analytics, kind of like what I talked about with MasterCard, they collect a lot of data, when they’re doing these proxies about where, who the investors are and how much they owe, they can packages in the analytics and sell it to financial advisors that may or may want to prospect, they’ve also got a very strong business kind of separately outside of the proxy business, in in processing transactions for kind of mid sized capital markets firm. So it’s, it’s, there’s a diversification benefit to it, too. So it’s, we think, a strong business. Also like ADP, not as pronounced, but they have a business where they hold cash for clients. And this is it’s called, it’s a business called matrix financial solutions. And they provide trust and social services to financial institutions. They it the last quarter, they said they had about 1.8 billion in assets under management, again, they can generate this invest interest income drops right to the bottom line, just like I talked about with ADP, and it’s some kind of an inflation hedge that that sits there underneath the surface for what we think is a very strong business. And again, if you look at kind of where we at markets day, short term, Robert shares have also pulled back a little bit start the year, also classified as technology stocks, we think there’s been some pressure there. They also it just noticed some a bit more margin pressure than they were expecting due to wage inflation. So we kind of talked about that before. So this is one place where it manifests. And then they’ve digesting a recent acquisition. But so we recognize the short term, but I think it’s more important, we think it’s more important to focus on the long term, which is a very strong business with with good long term growth drivers and also kind of a natural inflation hedge.
Nathaniel E. Baker
Interesting. Yeah, I just looked the stock is down 19%. Year to date. So in these two months and couple days, so it’s still up a bit on a year ago, but it looks like it might be a good pretty good buying opportunity here. Yeah,
Allen Bond
yeah, like I said, we, you know, we’re we, our view is it’s kind of gotten dragged down with some of the other finance or the other technology companies, and then it didn’t do well on earnings. So when they reported earnings last month, there was some disappointment with with guides, how they didn’t take their earnings down, they just took their margin target down a little bit. And they said, We’re gonna put aways but, you know, again, this is one of those things as investors as long term investors, we think it’s really critical beeware In the short term, you know, and we have to, you know, it’s easy to our long term, let’s ignore the short term, but I think the short term can provide opportunities and can provide these disconnects that we can take advantage of, it’s kind of a, it’s kind of a patience arbitrage, if you will.
Nathaniel E. Baker
Interesting, okay. By the way, this company, I don’t know, for this, this company, but ones like it, I wonder how responsible they are for maintaining print productions, and making sure that print productions don’t go away? Because I don’t know about you. But even though I’ve told them a million times, I went paperless they send me in a mail, it seems every year, all these proxy disclosures,
Allen Bond
and, yeah, there’s a bet that there’s a really ongoing, big, ongoing dialogue about that, um, Broadridge said, so they in that business, again, they’re paid on a per communication basis, but then they they charge a distribution fee if it’s paper based, right. So, um, so that’s just to cover the cost of distribution. But there’s no profit in that, right. So what they’ve said is, look, if the if we can get this mix shift to electronic, which they expect, and they’re trying to enable, on a nominal basis, our revenues will be under pressure, because we will lose that distribution fee. However, on a profitability basis, we more than make up for that because we were making money on that anyway. So maybe it just means profit margins go up. And so they’re I wouldn’t say they’re, they’re not indifferent to it. They’re there. They’re advocates of making communications electronic. The big issue with that is the regulators actually a regulatory push back a little bit because one of the things regulators regulators want is they want investors to be like, get the better word invested in the companies that they own, meaning they understand what’s going on from that that governance standpoint. And so there’s this push and pull between yes, we want efficient communication, which means electronic communication. We also want investors to be aware of governance and We want them because proxy voting, I think maybe 20%, I can’t remember the number off top my head, only about 20% of investors actually vote their proxies. So the regulators want that number to go higher. They’re concerned that if if it’s too electronic, or too summarized and new that that engagement goes down. Yeah, fair
Nathaniel E. Baker
enough. So that has never kept me from throwing it out or recycling it right away when I receive it. But yeah, we should, I should, but you know, you know what, it’s a fair point and absolutely should be aware of these things. And, you know, I don’t and like 20% of people vote proxy. So yeah, like you said, Alright, lastly, here, another stock. This is one that certainly everybody has heard of, in the news, often, obviously was in the news last year in the vaccine, has had a bit of a hard time since reaching the highs there. Late last year on the vaccine, this is Pfizer. Talk to me about that.
Allen Bond
Yeah. So that’s why I threw this in the last minute. Because I, there’s a lot of interest in Pfizer. We wrote a piece for our own, like internal or our stuff that we’ll send out externally and it but it was it when the vaccine got first approved, and it’s still on was read piece of last year. So we know there’s a lot of interest in Pfizer. So I’ll try to keep this short. But I think what what’s interesting about Pfizer right now is kind of a yen, there’s a short term storing a long term story. So Pfizer, well known company, one of the largest biopharmaceutical companies in the world, what we think is important, we’ve been Pfizer since 2018. And really, the crux for our investment thesis is they have a very diversified drug portfolio. And that’s a that’s a that’s, that’s unique, because a lot of even the big pharmaceuticals, they may have one or two drugs that account for most of their revenue. This is the way the business works. Pfizer has some big drugs, but maybe instead of being 30% of revenue, they’re closer to 10. Right. So it’s a bit more diverse, but they have a leading breast cancer drug and hybrids, they have a leading vaccine for pneumonia, and Prevnar. And they have a leading and growing drug that it’s like a blood thinner. So it’s used for people when they have irregular heartbeats, or to prevent blood clots after like a an orthopedic procedure. So these are really good, strong growing drug franchises right now. And it’s it’s diverse, and then they will go a lot more beyond that same thing with their pipeline, very diverse pipeline, and they’ve done a really good job under the leadership of, of giving us really good data about the pipeline, and allowing us to analyze it kind of peek under the hood a bit more than maybe we had in the past. That’s kind of been our investment thesis with Pfizer, obviously, in the short term, they’ve had phenomenal success with COVID. And, you know, put it in context, they’re going to generate as much revenue from COVID, as it’ll actually take them, they’re going to generate almost as much cash flow this year as they did revenue two years ago. And a lot of that’s because of the success they have with COVID. So they have the leading by far leading COVID vaccine in the US. And then the other thing is so like getting talked about a lot of the President brought it up, the State of the Union is their COVID, anti viral. And what’s interesting about that the COVID vaccine, the developed with a German company called biotech, the anti viral they developed it internally. And it’s basically the way it works is it’s a protease inhibitor, which is basically an approach to the HIV treatment is based on it’s basically prevents the virus from replicating as well. In Pfizer didn’t really have a established HIV program. So it kind of it just kind of came out of internal work. And then even maybe they had a drug on the shelf somewhere. And they said, Oh, let’s see if it works. And it did. But it’s it’s a really neat drug because it attacks the virus in a way that should be more resistant to mutations being that it could be part of the solution that gets us over the pandemic phase and into we can deal with this virus phase. Um, and so those two drugs have been phenomenal. And then the big question we’re asking ourselves investors right now is, what what’s the magnitude of these drugs? And then probably more importantly, is what’s the longevity? How long do we need COVID vaccines? And how long is COVID antivirals gonna going to work out. And so that’s kind of where the uncertainty is, if you try to look through that, and I think this is what I wanted to talk about, in the short term, which is back out all of the COVID related revenues as best we can stocks trading at about 1718 times earnings, which is kind of average, maybe a little bit above average for peer group stocks, and that space. And that’s what we’re the markets we’re trying to grapple with. And as you mentioned, the stock did really well in the fourth quarter. And I think that was a lot of optimism about that, that um, antiviral drug. And it’s now we’re kind of coming back in Okay, well, what’s the run rate? What’s, you know, where do we go from here? And there’s still a lot of unanswered questions there. And uncertainty, no one likes uncertainty. So that could be part of the pullback, in addition to profit taking is a phenomenal stock last year. Um, here’s the that’s the short term. The long term is this. Pfizer is generating a ton of cash right now I mentioned they’re going to generate we expect to generate as much cash this year as they generated revenue two years ago. And that’s because of the success with their COVID programs. And what they are doing with the cash and they’ve been very explicit about this is they’re focused on kind of the later part of this decade. We know they’re gonna lose exclusivity on some of these large drugs I talked about.
Allen Bond
They have an existing pipe focused on that, they’re going to use this cash to invest more in that lot, I would expect to see a lot more acquisitions, they just announced an acquisition of a company called arena pharmaceuticals late last year. So they paid $6.7 billion for that. And they have about 30 billion of cash on the balance sheet, they’re going to get about 4 billion from they own part of GlaxoSmithKline, consumer products, JV, that’s going to get spun out, they’re expecting to about 4 billion from that. And they’re going to generate about 40 billion in cash this year. But add all that together, they could do about 10 of these types of deals, they did the arena deal is they’ve got a very promising autoimmune drug, where there’s, there’s kind of a proven, hey, we can we can treat this, but there’s still a lot of unmet need. So it’s a very promising space. And there, we expect him to continue to look for more of these types of deals to backfill the drug pipeline, what gives us confidence is a that cash flow is the ability to do that. And with a newer management team, they’ve really demonstrated the ability to have real acumen about where medicine is going. And so we think this is a really good opportunity, that long term opportunity there to, to get in and in and out a company where there’s a lot of cash being generated and a lot of opportunities to invest that cash.
Nathaniel E. Baker
Yeah, yeah. I mean, you talk about somebody that’s been, you know, ahead of a lot of maybe not ahead of, but they’ve managed to meet a lot of these challenges, you know, for decades now, and managed to reinvent themselves several times, maybe not reinvent themselves, or just, you know, get new pipelines of drugs, many times here, and it would certainly be something that would be tough to bet against. And especially now this tool is down 19% this year. And it’s you know, it also gives you a picture 3% coupon 3.3% dividend, yeah, the current prices, like, you know, that’s yeah,
Allen Bond
you’re getting you get paid to be, you’ll get paid to be patient with this one. And in in again, we’re trying to identify stocks that have sold off a little bit this year, kind of that short term, long term piece. And yeah, the short term piece is exactly what I just said, there’s uncertainty about the longevity of those drugs, and then probably a fair amount of profit taking, based on the success that Pfizer hit that the stock has coordinates. So we think we’re kind of this lol. And as some of those questions start to get answered, and their ability to to identify other other good targets for feature drug pipeline. We were that’s something we’re gonna monitor and make sure that we’re, you know, staying on top of because that’s really the kind of that that key to that long term story.
Nathaniel E. Baker
Is this the kind of company where they make an acquisition, and the market actually rewards it? Because most of the time, the typical m&a playbook is that the acquire stock sinks. But if it’s a growth company, or I guess, maybe something like this, it goes the other way. Because, you know, the market gets more excited about the prospects for future growth. So, you
Allen Bond
know, so you’re right. Um, so it’s a mix, it’s the answer to that, at least in my experience is yes. And no, I’m with Pfizer, given that they’re spending internally generated cash, the calculus is going to be how, you know, what price are they paying for these, these things. And the tricky part with pharmaceutical companies is, oftentimes, they are buying companies with no revenue. So you’re, you’re basically, you’re basically having to make an assumption about what future revenue could be. So you’re looking at it like, it’s like this, this company they just bought, they have a very promising auto immune drug. And so we kind of know, there’s a lot of growth in that space, it’s an area of a lot of innovation, and, and there’s opportunity, there’s a lot of opportunity there. So we can kind of put some sort of a probability on the fact that milk is successful, it’s going to be able to be marketed. And if all that happens, you know, any price you pay is probably getting pretty good because of the future success. You could have there. But it’s binary, because if if something fails, then now so that it’s really hard. It’s my point is it’s really hard, you almost have to the pharmaceutical company, you have to try to understand what they’re trying to pursue from a disease area standpoint. And then, you know, if there’s a little bit of a leap of faith that they’re that, that they’re gonna be able to be successful in these drugs. And to us, again, it would come back down to we’d much rather see Pfizer do 10 of these types of deals, and maybe be successful on seven of them, then try to do one big deal. Put all your eggs in one basket that’d be much riskier in that regard, because we really won’t know the success of this deal for probably several years to come. Yeah.
Nathaniel E. Baker
Very interesting. Alan bond. Thank you so much for joining the contrarian investor podcast today. Maybe in closing, you could tell listeners how they can find out more about you. And about the your company and I’ll put this in the show notes too. So people have the links.
Allen Bond
Yeah, so Jensen investment management. We were a boutique firm, based outside of Portland, Oregon. We manage about 13 billion in total assets across three equity strategies. I think the one thing to note with Jensen is we are an independent firm. We’ve been independent states since day one we strive to remain independent forever and we have a successfully transitioned ownership from from kind of the first, second. Third, we’re already in the fourth generation of ownership. So we, we think that makes us somewhat unique as a boutique firms. We’ve demonstrated independence.
Nathaniel E. Baker
I don’t think you’re active on social media at all. There’s a big Twitter community in the investment
Allen Bond
world, but yeah, yet we’re we were active on LinkedIn. Okay. And so you can find us there. Not so much on Twitter yet for Yeah,
Nathaniel E. Baker
yeah. Very cool. But you’re doing podcasts. That’s definitely one step in the right direction. And very thrilled to be able to take advantage of that and have you come on and share your wisdom here with us. So with that, we thank you all for listening. Thank you again, to everyone for coming on. And we look forward to speaking to you all again next time.